Alchemy of Financial Innovation: Securitization, Liquidity and Optimal Monetary Policy
61 Pages Posted: 20 Feb 2019
Date Written: February 20, 2019
This paper provides a theoretical model to explain how securitization affects the overall liquidity and welfare of an economy, an under-discussed area in the literature. By applying an overlapping generations model with random-relocation shocks, the effects of securitization are analyzed in three different hypothetical situations:
1. only one region of the economy issues securities,
2. all regions issue securities with the same capital productivity, and
3. all regions issue securities, but capital productivity is disparate across regions.
Asset securitization plays a role in supplying alternative liquid assets (fiat money). As the economy can invest its resources more efficiently in high-yielding illiquid assets (capital) due to securitization, both consumption and welfare increase overall. Optimal monetary policy follows the Friedman rule in cases 1. and 2. However, the rule does not apply in case 3.
Keywords: Securitization, Liquidity, Friedman Rule, Monetary Policy
JEL Classification: E52, G11, G12
Suggested Citation: Suggested Citation